Jonas Elmerraji's  Instablog

With pretty much all major indexes pointing toward a lower market open this morning, it's time to think about the scary reality of the that stocks are facing right now... Welcome to the failure zone:

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Make no mistake: the tumble stocks took in late 2008 has changed the way we invest. The uncertain market has changed our risk appetite. Right now, most eyes have turned to the “widow and orphan stocks” – the stocks deemed safe enough for even the most unsophisticated and conservative investors.

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Another modest trading week is wrapping up -- what better time to take a look at the market?

Last week, I told you that the market we're in strongly resembles the unchecked rally that we "enjoyed" between March and early June. This latest leg has already pushed the S&P 500 up 15.2% since mid-July, though it's finally starting to waiver:

Since the beginning of August, the S&P (a proxy for market at large) has been tracking sideways, and potentially consolidating. Consolidation is a good thing for the market. It gives the market a chance to cool down from quick gains, it provides the opportunity to form a base of support (a price level that the market has trouble falling below), and more fundamentally, it gives investors a chance to take a breather and rethink their market positions.

But a sideways market doesn't always mean that consolidation is occurring.

Just as often, it's the sign of a reversal -- and the last chance to get out of stocks before a significant drop. On the daily chart above, you can see that a base is forming for the S&P 500 around 992. But there are three red flags as well: the August 11 bounce off the trend-turned-resistence line, declining aggregate volume, and bearish MACD crossover.

These three things don't guarantee that the market's set for a fall, but they should give pause to the perma-bulls who are scooping up stocks right now. If we continue to track sideways -- or better, break back up through that upward blue trendline, we will have a very strong reason to believe that this rally will continue for at least several hundred more points. Until then, be very cautious.

Do Fundamentals Matter?

Many investors are wondering what matters in this market -- fundamentals (like earnings and inventory turnover) or technicals (like the chart above). The answer is both.

Scores of investors and traders have been making money in this market -- even now. And for the most part, Rhino Stock Report readers have been doing even better (i.e. a 35% average closed gain). It's hard to go wrong by choosing companies with solid fundamentals during strong market cycles. So that said, let's look at the other half of this equation:

Markets: The S&P and Dow are up 2.6% and 2.5% respectively, despite mixed economic data. That's proof that investors big and small are turning bullish in bigger numbers -- and according to the latest investor sentiment numbers the bulls have grown their ranks by 13% in the last three weeks.

Economy: The economy is getting better according to the Fed. And in the latest quarter France and Germany -- Europe's two biggest economies -- actually grew. Across the world, things appear to be getting better, unless you count the fact that U.S. government reported a record YTD budget deficit in July -- a full three times larger than last year's record deficit. And we've still got two months to go...

Earnings: We're at the tail end of earnings season for Q2 2009 right now. And most of our companies posted strong numbers. A few big names like Microsoft (NASDAQ: MSFT) and Amazon (NASDAQ: AMZN) missed earnings, but on the whole this quarter has rung in as a success to investors. Does that justify seeing the S&P 500 20% higher in the next six weeks? I hate to say it, but probably not.

Disclosure: No positions

Friday marked the first day since last October that the S&P 500 stayed above 1,000 for the entire trading day. Can we hold at that level? Here's a look:

Two things are significant about this chart right now: the head and shoulders fake-out that took place between May and July, and the steep uptrend that the market's been on ever since.

A "head and shoulders" pattern is a very bearish sign to technical analysts that suggests that the market is due for a downward swing. Scores of traders watched the S&P nervously as it formed -- and many likely took short positions on the market when it looked like the pattern was going to follow through. In the end, the pattern was a fake-out, and the S&P 500 index bounced off of its 200-day moving average. It hasn't looked back since.

The fact that the head and shoulders pattern didn't materialize is significant for investors. It means that despite all indications that the market was going to take a dive, investors were bullish enough to fight the downward pressure -- and win.

And with the risk of a tumble out of the way, the market rocketed off, blowing through several key resistance areas. While that's been great for investors up to now, it should also be a cause for concern. Like we talked about back in May, an unchecked rally isn't a good thing, and this one's no different.

That said, as the S&P crossed 1,000 (a psychologically significant number for traders) it has slowed down and appears to be consolidating. If the S&P tracks horizontally for a while, we could have a decent enough base to climb even higher. That remains to be seen.

Not Following Fundamentals

Whether a climb much higher is fundamentally warranted is another question. Economic data continues to be mixed, as do earnings. Still, the consensus seems to be that investors are quite happy to be bullish until the evidence tells them otherwise. That means "mixed" fundamentals will continue to support an upward market.

According to the American Association of Individual Investors' latest polling, half of all investors are bullish right now, versus just 35% who call themselves bears. That's not a surprising statistic given the rally we're in the midst of.

Your 26.73% Gains

It's been 9 months since I published our first recommendation in the Rhino Stock Report. Since then, I've talked a lot about how well our positions have been doing, but for a change, here's a graphical look:

The graph above shows the Rhino Stock Report's performance since inception versus an investment in the S&P 500 and a high-yield savings account over the same period. The difference speaks for itself.

And now, Rhino Stock Report membership is free. The bar's been set pretty high, but we'll do our best to keep it going as we finish out 2009.

Disclosure: No positions

Friday marked the first day since last October that the S&P 500 stayed above 1,000 for the entire trading day. Can we hold at that level? Here's a look:

Two things are significant about this chart right now: the head and shoulders fake-out that took place between May and July, and the steep uptrend that the market's been on ever since.

A "head and shoulders" pattern is a very bearish sign to technical analysts that suggests that the market is due for a downward swing. Scores of traders watched the S&P nervously as it formed -- and many likely took short positions on the market when it looked like the pattern was going to follow through. In the end, the pattern was a fake-out, and the S&P 500 index bounced off of its 200-day moving average. It hasn't looked back since.

The fact that the head and shoulders pattern didn't materialize is significant for investors. It means that despite all indications that the market was going to take a dive, investors were bullish enough to fight the downward pressure -- and win.

And with the risk of a tumble out of the way, the market rocketed off, blowing through several key resistance areas. While that's been great for investors up to now, it should also be a cause for concern. Like we talked about back in May, an unchecked rally isn't a good thing, and this one's no different.

That said, as the S&P crossed 1,000 (a psychologically significant number for traders) it has slowed down and appears to be consolidating. If the S&P tracks horizontally for a while, we could have a decent enough base to climb even higher. That remains to be seen.

Not Following Fundamentals

Whether a climb much higher is fundamentally warranted is another question. Economic data continues to be mixed, as do earnings. Still, the consensus seems to be that investors are quite happy to be bullish until the evidence tells them otherwise. That means "mixed" fundamentals will continue to support an upward market.

According to the American Association of Individual Investors' latest polling, half of all investors are bullish right now, versus just 35% who call themselves bears. That's not a surprising statistic given the rally we're in the midst of.

Rhino Stocks Have Made 26.73% Gains on Average

It's been 9 months since I published my first recommendation in the Rhino Stock Report. Since then, I've talked a lot about how well our positions have been doing, but for a change, here's a graphical look:

The graph above shows the Rhino Stock Report's performance since inception versus an investment in the S&P 500 and a high-yield savings account over the same period. The difference speaks for itself.

And now, for a limited time, a subscription to the Rhino Stock Report is absolutely free for Seeking Alpha readers. Just visit www.rhinostocks.com/subscribe

Disclosure: None

As expected, the S&P 500 surged another 4% in the last week, making things especially interesting as the nation prepared for the big banks' stress test results and a slew of mediocre earnings... More on that later.

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